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Brexit – what investors say

16 November 2018

As the UK’s exit draws nearer, we turn to our fund managers and consultants for their views on investing through Brexit.

Despite the long lead time between referendum and formal exit, Brexit remains a great unknown.

Amid such uncertainty, currency and equity markets have, unsurprisingly, reacted strongly both to the initial referendum and to major developments in negotiations ever since. The pound has not recovered the ground it lost in the week after the referendum; UK economic growth has been largely sluggish; and stocks with heavy domestic exposure have underperformed.

Of course, markets dislike uncertainty and, as events twist and turn, it is still impossible to forecast what Brexit will look like. Continued volatility is inevitable and the challenge for professional and private investors alike is to look beyond such periods and focus on the longer-term prospects for companies and economies.

Unholy Trinity?

After the events of recent days, there appear to be three outcomes that remain possible:

  1. DEAL: Parliament ratifies Theresa May’s proposal, enabling a deal-based exit on 29 March 2019.
  2. NO-DEAL EXIT: Parliament votes against the proposal and the UK leaves the EU without a deal.
  3. DELAY: Parliament votes against the deal, potentially triggering a change in leadership, a general election or even a second referendum.

Outcome three is less immediate and would open up a new range of possibilities and problems to consider, whereas more meaningful consideration can be given to outcomes one and two. So, what do different investors believe these two outcomes might mean for markets?

DEAL

  • Redington, investment consultants: having run Brexit stress tests, Redington believes a deal in which the UK stays in the customs union (as would initially be the case) would be a “growth scenario” that could spark “rising interest rates, sterling appreciation and tightening credit spreads”. UK equities would then rise slightly and a negative trade shock would be avoided.
  • Llewellyn Consulting: John Llewellyn, economist, believes continued access to the European Single Market “would maintain matters largely as they are but would strengthen confidence”.
  • Magellan: Hamish Douglass, fund manager, believes that a withdrawal deal approved by all the relevant parliaments would at least provide a “logical but difficult” way forward.

NO-DEAL EXIT

  • Invesco Perpetual, fund manager: “It is difficult to avoid the conclusion that a hard Brexit will be detrimental to UK growth in the short to medium term [largely due to] an unwillingness to make investment decisions in an uncertain time and disruption as businesses adapt to a new trading environment.”
  • Magellan: Douglass believes “a hard Brexit is a default and terrible in the short term”.
  • Redington: while a hard Brexit would be negative (leading to recession and a 10%+ fall in equities), a no-deal Brexit would be worse, as “the UK possibly enters a period of stagflation – rising inflation combined with a fall into recession. Rising prices would hit the public finances and increase inflationary pressure. For this scenario, we envisage a 15% fall in UK equities.”
  • Llewellyn Consulting: a no-deal exit would “threaten massive disruption and heighten uncertainty further about the UK’s longer-term prospects… A hard Brexit would almost certainly weaken sterling further. This would hurt many domestic stocks but boost those of companies that produce international goods.”
  • Capital Economics: “Even if Theresa May survives, the key point is that the chances of her deal being passed by parliament are not looking good. There is therefore still a good chance (we’d say 50/50) of the UK leaving the EU without a deal, but the impact of this on the economy would depend on how “orderly” a no deal it was.”

Investing for Brexit

But how do fund managers factor different possible Brexit outcomes into their portfolios, investment decision-making and analysis of individual companies’ long-term prospects? And how might sterling’s fluctuations affect stock valuations?

“We expect sterling to continue to oscillate based on the assessment of Brexit risks,” says Johanna Kyrkland of Schroders. “Indeed, we view it as a critical shock absorber in the event of ‘no deal’, as a weaker pound would help to boost the value of overseas earnings for UK companies. There will be a few nail-biting days as we confront the nature of Brexit but the performance of equities over the next year is more likely to be driven by the direction of interest rates and the outlook for global growth.”

Jim Henderson, of Aristotle Capital Management in the US, has already witnessed the potential for Brexit-related immigration shifts to impact a single stock’s performance, and believes the same trend could yet influence markets again.

“While Brexit has already had an impact on one of our holdings (Acadia Healthcare), we don’t really have a position on what is, at its core, a political process,” says Henderson. “The impact mentioned has to do with a labour shortage at Acadia’s UK division. Much of the labour pool in the services and hospitality industries in the UK come from Eastern European nations. I can understand that flow slowing if an individual contemplating immigrating to the UK is unsure if they will be allowed to stay.”

Burgundy, which invests in European equities, believes that Brexit will present challenges to companies and investors alike, but that those with a long-term perspective will still find opportunities.

“Brexit may well prove a stern test of the ability of businesses to adapt and thrive, but the best will. [Companies in the portfolio] earn revenues around the world – on average, the UK accounts for well under 10% of the revenues of UK-based companies in the portfolio. In the two decades we’ve been managing European equities, we’ve seen the Tech Bubble, Global Financial Crisis, Euro Crisis and more – every occasion offered the disciplined contrarian investor opportunities because other investors responded with a short-term perspective rather than a long-term one.”

Nevertheless, identifying those opportunities this far in advance may be a fool’s errand. Hamish Douglass of Magellan believes caution is therefore needed for the moment when it comes to heavily Brexit-sensitive stocks.

“The outcome is too uncertain at this point to factor outcomes into investment decisions,” says Douglass. “Furthermore, our portfolio does not hold investments that would be impacted significantly one way or the other.”

Indeed, caution may be all the more important, given the potential fallout: John Llewellyn, an economist, believes Brexit has major implications for the UK economic outlook.

“The UK stands to be affected most, as the EU is around four times more important to the UK [than] the UK is to Europe,” says Llewellyn. “But the effects on European economies would nevertheless be significant, as many German and French business people are saying. In the UK, manufacturing would be hit hard, but agriculture, fishing and food would also be seriously affected. Some financial services would be wounded – others less so. The UK economy would ultimately adjust, but it would take at least a decade.”

Yet that is not the same as saying the UK will not ultimately come out strong. “I can only add that the UK was an economic powerhouse before the advent of the European Union and will continue to be an economic powerhouse long after Brexit,” says Aristotle’s Jim Henderson. “It could, however, be a messy path.”

 

Aristotle, Burgundy, Invesco Perpetual, Magellan and Schroders are fund managers for St. James’s Place.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

The opinions expressed are those of Aristotle, Burgundy, Invesco Perpetual, Magellan, Schroders, Capital Economics, Llewellyn Consulting and Redington and are subject to change at any time due to changes in market or economic conditions. This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or adopt a strategy. The views are not necessarily shared by other investment managers or St. James’s Place Wealth Management.

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